Interest Only Mortgage

An interest only mortgage is when you pay only the interest on the mortgage balance in your monthly payment throughout the term of the mortgage. At the end of the term the lender will require you to pay off the outstanding balance, which will not have decreased, from your own funds. Although it is recommended many lenders no longer make it compulsory for the borrower to put some form of investment product in place to accumulate the funds to pay off the balance over the term of the mortgage.

Endowment

This is the most common type of interest only mortgage which also provides life assurance cover and a fixed payment for investment. The fixed payments are based on the amount of the loan together with the mortgage term and are designed so that, at maturity, the amount invested and earnings are sufficient to pay off the mortgage. Much maligned in the press because of the poorer investment growth rates achieved in a low inflationary environment, this form of investment is less popular these days. Note there is no guarantee that, when the endowment matures and "pays out", the balance will be sufficient to repay the mortgage.

Endowments provide life assurance so that in the event of death the mortgage is paid off.

ISA

The Individual Savings Account (ISA) is a tax free method of saving. Using an ISA as a repayment vehicle is growing in popularity but due to the ISA’s complexity it is only for the financially sophisticated or borrowers taking advice from a suitably qualified financial adviser.

Pension Plan

Life assurance cover is provided and monthly payments are made into a pension fund. When the benefits are eventually taken, the mortgage is repaid using tax-free cash from the remainder of the fund. The plan holder can then draw a pension from the balance of the fund. This product, which tends to be used by the self employed, is only for those taking advice from a suitably qualified financial adviser.

Advantages of an interest only mortgage

  • If the proceeds of the plans exceed the amount required to repay the mortgage, then this is received as a cash lump sum by the borrower.
  • Some plans are tax-efficient.

Disadvantages of an interest only mortgage

  • If the proceeds of the repayment vehicle do not achieve the amount expected, then there will be a shortfall. The borrower remains liable for any shortfall on the mortgage hence the outstanding balance will need to be paid off from other resources. Regular checking of the policy fund itself by the borrower and the lender should minimize any risk. If the plan is not reaching its expected target, the borrower can increase payments into the policy or invest in another product to cover any anticipated shortfall.
  • Cashing in the plans early may result in financial penalties. These will be provided for in the initial agreement. In addition the lender has no way of tracking some of the more modern repayment vehicles, such as an ISA, which will result in some instances where a borrower lets an investment lapse forgetting or not realizing it is to be used to pay off the mortgage. This will result in situations where there is no method of paying off the mortgage and the lender will only become aware at the end of the mortgage term.